How home equity loans work, and who they suit best.
How do equity home loans work?
When we talk about an equity home loan today, we are referring to a line of credit, or a loan where you can easily access money right up to its limit – and repayments are made on an interest only basis on the outstanding balance only.
Brilliant for serious investors who wish to have ready access to enough cash to grab an opportunity and manage their cash flow at the same time, this is generally the borrower who takes up this type of loan. What I mean is they allow you to write a cheque from the account that could cover an investment property deposit, without you having to seek approval from your current lender – and while you’re waiting on the opportunity it isn’t costing you interest, as interest is charged only on the outstanding balance. Think of this as resembling a giant credit card as it ahs very similar attributes, including usually attracting a premium interest rate.
Because you are not obliged to make principle repayments, its not usually ideal for someone who is looking to pay off their loan quickly or at all, as such very few lines of credit facilities are offered to home owners other than as a secondary split for other purposes.
In past we have seen schemes arise where equity loans or lines of credit were used to reduce home loans quickly - by crediting all income into this account and using a credit card system to leave the income in the account longer – automatically paying the credit card at the end of the month. While this actually works well in theory, the falling down is often in the understanding that to pay off the loan you need to actually leave the money in there – permanently.
That’s not to say you can’t pay your bills, but you need to commit a component to pay off the principle of the loan balance. These were popular back in the early 2000’s, the era of the giant, expensive home theatre systems and what commonly happened, and I am speaking from experience, is the home owner would see there was an available balance in the account and simply spend it, never actually getting ahead in their loan.